Reverse Mergers: An alternative to IPO's

18-05-2003

Initial Placement Offerings are very expensive when all fees and costs are taken into account. Market forces can also make IPO’s very unattractive, in bear market periods. An alternative is the reverse merger. Market developments in North America are definitely driving this process to greater popularity, for getting public status. The UK and Europe are certainly not too far behind.

If a company may benefit from being listed on Wall St. the Dow Jones or NasDaQ the reverse merger route has to be an option to consider. The process of a reverse merger is equally applicable for an OFEX, AIM listing or a full listing on the London Stock Exchange and many other leading exchanges around the world. This article describes the reverse merger concept and route, based on the regulatory requirements of the US. Variations will exist in every territory around the world.

There are 3 ways for an issuer to go public:

1. Traditional IPO.
2. Self-filing a registration statement (SB-2) or equivalent.
3. Reverse merger into a public shell, via either a:

• Blank check company pursuant to SEC Rule 419; or
• Publicly trading shell.

Facts about Traditional IPOs

• The cornerstone of the traditional IPO process involves the selection of an underwriter by the issuer and vice versa. Post the dot-com era, investors (and by definition underwriters) have become much more demanding about the standards for purchasing IPOs.
• Once an underwriter is selected, the issuer can only become public after a lengthy and expensive process that is further subject to both the underwriter’s corporate finance calendar and market conditions.
• For the first four months of 2003, the average IPO was in registration with the SEC for 121 days. In reality, the process from start to finish takes well over a year and for a small offering can easily cost over $1 million.

IPO Statistics: 2003

• January 2003 was the first month without an IPO since 1974.
• As of April 30, 2003, Wall Street had priced only 5 IPOs, raising a little over $600 million.
• This is the sum total for every investment banking firm including Goldman Sachs, Morgan Stanley, and Merrill Lynch on down to the 5,000 or so other broker-dealers in the United States. And this is in a market environment where through the end of April, all of the major indices are up for the year (Dow: +2.4%; S&P 500: +4.8%; Nasdaq: +9.8%).
• The average size of an IPO in 2003 is $198 million.
• The trend for microcap IPOs is even worse. In 1997, there were 125 IPOs in which the issuer raised $25 million or less. In 2000, there were 18. In both 2001 and 2002, there were only 6. Bancshares of Florida, Inc. (BOFL) is the only issuer that has offered below $75 million of securities through an IPO in 2003.

IPO Statistics: A Historical Perspective

• In the first quarter of 2002, 17 IPOs raised $10.2 billion.
• During the 1990s, Wall Street priced a total of 5,681 IPOs. That works out to an average of 47 IPOs each month during the 10-year period.

Conclusion

• For the past three years, it has become extremely difficult for any issuer, let alone a microcap company, to go public via an IPO in the U.S.
• There is no indication that market conditions will change in the foreseeable future

Why Should a Small Company Go Public at All?

• Public companies trade at a significant premium to private companies.
• Public company stock can be used as acquisition currency.
• Public companies have superior access to capital for future financings.
• Most microcap companies are not eligible for bank loans.
• Venture capital funding is virtually unobtainable.

Facts about Self-Filing a Registration Statement

• An issuer can file a registration statement (SB-2 or equivalent) with the assistance of its lawyers and accountants.
• Once the SEC declares the registration statement effective, the issuer becomes a publicly reporting company. Unfortunately, that’s all it becomes—the issuer would NOT be publicly trading even though it is publicly reporting.
• NASD Rule 2460 specifically prohibits broker-dealers from accepting any payment or other consideration, directly or indirectly, from an issuer of a security, or any affiliate or promoter thereof, for publishing a quotation, acting as market maker in a security, or submitting an application in connection therewith. If an investment banker can’t be compensated for these activities, what’s the incentive to get involved? Answer: none. Without some reward, there is simply no incentive for a market-maker to assume the significant liability incurred by filing a Form 211 on behalf of an issuer.
• Self-filing a registration statement without a clear (and legal) capital markets strategy is a trap: an issuer gets all the obligations (and expenses) of public reporting without any of the benefits, i.e. being publicly traded.
• Further, by self-filing, an issuer denies itself access to the expertise and considerable value that a reputable investment banker would otherwise bring to bear.

Facts about Reverse Mergers

• Going public via a reverse merger saves both time and money.
• A reverse merger into a reporting and trading shell can be completed in 30 days.
• A reverse merger into a blank check company can be completed in 120-180 days.
• In the case of either a trading shell or a blank check company, the cash cost is going to be approximately 10-25% that of a traditional IPO.
• The major differences between using a trading shell and a blank check company to complete a reverse merger are as follows:

1. Time: 30 days for a trading shell versus 120-180 days for a blank check.
2. Cost: $200,000 for a trading shell versus $100,000 for a blank check.
3. History: a trading shell is a failed public company whereas a blank check company is a newly created, and therefore, pristine public entity.

Choice of Publicly Trading Shell vs. Blank Check

• In those cases where time is critical, such as the need to raise capital immediately, the process of reverse merging into an already publicly trading shell is preferred. Having a stock price with market makers already in place creates clear and tangible visibility for the issuer. By offering securities at a significant discount to the market price, an issuer gives investors an incentive to act quickly.

Summary

Back To News Menu